You’ve finally made it. After weeks looking at properties and finalizing a sale, and hours spent reviewing applications and showing your property: the lease is signed, the tenants have moved in, and the first month’s rent is safely deposited in your bank account. Before your spending spree, first consider the reasons why every rental home owner needs a reserve fund.
You’ve probably already thought of what you want to do with that extra income. It is an exciting moment, after all. Maybe start saving for a second property or a long awaited vacation. Or you could pay down your primary mortgage, make an extra car payment, or look at investment options.
Not so fast. The first thing you need is a reserve fund.
Any seasoned property owner will tell you to expect the unexpected. Unforeseen costs, like repairs, vacancies, and maintenance, can materialize at the most inopportune times. Other expenses, like insurance and taxes, are more routine and should also be in the budget for your investment property. That’s why every rental home owner needs a reserve fund.
Landlords who don’t anticipate these costs will quickly find themselves deep in a financial hole. New landlords should plan on putting 100% of net income from a rental property into a cash reserve until a sufficient amount has been saved.
A healthy reserve fund can help cover expenses like:
- rent shortfalls
- major repairs like a roof, HVAC unit, or major appliance
- insurance deductibles
- property taxes
How much do I need?
Ultimately, the total amount of cash you should keep in reserve will depend on the particulars of your property and the market where it’s located. Older homes require more repairs than newer homes. Property services in urban areas typically cost more than those in small towns or rural areas. Deductibles vary by insurance plan.
An initial reserve fund of $5,000 is a good start for most rental property owners. It’ll cover most insurance deductibles – all but the most major repairs – or a few months of mortgage payments if you have an extended vacancy. But, that’s just a starting point. Once you’ve established your initial reserve fund, set aside a certain percentage of your profit each month until you’ve reached a total equivalent to three to six month’s rent.
Don’t forget, once you use your reserve fund, you need to return to the practice of setting aside a portion of your monthly profit to build it back to a maintenance level.
You should know by now that you are required by law to keep the tenant’s security deposit in a separate bank account from the one you use for operating expenses. You may also want to consider keeping your cash reserves in a separate account, as well. This can make accounting simpler and help ensure your cash reserves only get used in situations where they are needed.
Related: Accounting for Your Rental Property
But, be sure your cash reserves are in an account that is easily accessible and liquid. You need to be able to access them quickly when needed.
Have more questions about reserve funds for rental home owners?
Give Greyhaven a call today at 423-648-6676 and get advice from one of our pros.